I Bonds

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DonDraper
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I Bonds

Post by DonDraper »

In the "I just inherited 1 million dollars" thread several posters recommended immediately purchasing $10k of I bonds for both the husband and wife. I'm wondering what rationale behind this would be?

I own I bonds and they are currently yielding a little over 1%. I understand they can make sense for certain investors for certain purposes but I never viewed them as an automatic must have for someone who just picked up a million dollars.

I didn't want to hijack that thread so I thought I would ask my question here.

On a related note I have $5-$10k in an online savings earning less than one percent. I was considering opening a PenFed 5 yr CD paying 3%. I'm thinking the odds of I bonds beating 3% over the next 5 years is probably 50/50? Which one would you go with assuming you don't think you will need the money for at least 5 years. I-bonds or PenFed CD?
z3r0c00l
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Re: I Bonds

Post by z3r0c00l »

No, I don't see why buying ibonds right away would make much of a difference to a person who just got a million dollars. However, everyone with enough money should be buying the max of ibonds every year anyway. So that is true of almost all investors - the bigger issue is with a million cash, what to do with most of it? The answer is stick to your AA - probably putting most of it into stocks and bonds, and any safe money would have to be in CDs that have no purchase limit. Not because CDs are better, but because they are the next best thing among limited options. If I had that kind of money, I would probably be more conservative because hey, you already won half the battle right? Others would use this as a chance to take on more risk.

As to your question, know that Penfed hits you pretty hard if you want to pull the money out of a 5 year CD. iBonds after the first year have a relatively minor penalty, and zero penalty after 5 years - yet they keep earning the interest comparable to a CD. They also dynamically adjust to inflation, and are the superior inflation protection on the market today. So iBonds are like a CD that changes rate often, is tax deferred, and has no penalty after 5 years. iBonds are better, but maybe 10,000 is not enough for your needs. However, everyone should take advantage of the 10K per year if they can and hope to have a reasonable amount, such as 100,000, in the future.
Last edited by z3r0c00l on Tue Dec 10, 2013 7:15 pm, edited 1 time in total.
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Johm221122
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Re: I Bonds

Post by Johm221122 »

What is your tax rate? Will it be lower in 5years ? State tax?would inflation worry you? But if tax issue and unexpected inflation are not major concern I would choose cd.
John
z3r0c00l
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Re: I Bonds

Post by z3r0c00l »

Johm221122 wrote:would inflation worry you?
There is an emotional aspect to this, however there is also a numerically superior outcome. We don't know what that will be, and the better odds are probably in favor of a 3% CD. But the potential losses from serious, say 5 - 7% inflation for 3 of the 5 years, trump in my mind the extra percent or so that you will earn in a CD. Also, if you put in for another 5 years, that CD penalty stays with you. You can earn a penalty-free return from the ibond with the small investment of 5 years time and keep it for decades if you want.
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Kevin M
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Re: I Bonds

Post by Kevin M »

It's a good question. At 1.38% nominal, 0.2% real, I Bonds are not particularly compelling compared to 3% nominal. 5-year nominal treasuries are only yielding only about 1.5%, so the PenFed rate is 2X the market rate. On the other hand, 5-year real rates are slightly negative, so obviously an I Bond also is superior to real market rates.

I have been buying I Bonds in January for the last three years, but I don't think I'll do so this year. If I buy my allotment of $20K (with my living trust) it will be later in the year. This is partially because I don't have a large excess of cash now, and I put what I could into the PenFed 3% 5-year CD.

However, having something in inlfation-protected investments is nice, so if I had $1M in cash, I'd max out I Bonds as well as buy the CD and other things.

Kevin
If I make a calculation error, #Cruncher probably will let me know.
Bacchus01
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Re: I Bonds

Post by Bacchus01 »

Still not clear.

Why buy them at all?
Johm221122
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Re: I Bonds

Post by Johm221122 »

Bacchus01 wrote:Still not clear.

Why buy them at all?
I bonds?
High tax rate (tax deferral)
Inflation protection
Deflation protection
Tax free education money
After 1 year can cash any day(5 years no penalty)
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dad2000
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Re: I Bonds

Post by dad2000 »

Bacchus01 wrote:Still not clear.

Why buy them at all?

10 years or less from retirement. 39.6% marginal tax rate. My tax-deferred is already filled with commodities/REITs/bonds, with all other equities in taxable.

So I rebalance by adding bonds to taxable. My choices are I-Bonds vs munis, and I think I-Bonds are a better choice for my situation.
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Re: I Bonds

Post by z3r0c00l »

Bacchus01 wrote:Still not clear.

Why buy them at all?
A promise to match inflation. No other safe investment can offer you that, not CDs and certainly not bank accounts.

What more do you need to know?
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am
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Re: I Bonds

Post by am »

I bonds do not match inflation after tax when the fixed rate is near 0.
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Kevin M
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Re: I Bonds

Post by Kevin M »

Another consideration is whether or not you own any TIPS or TIPS funds. SEC yield on Vanguard's intermediate-term TIPS fund (VIPSX) is -0.14%, and for the short-term TIPS index fund (admiral shares) it's -0.87%. So I Bonds clearly are far superior to TIPS now. You earn a small, positive real return with interest-rate risk limited to the EWP of three months of interest between years one and five (as long as you are OK with accepting no liquidity in year one). So, if you own TIPS in any form, and you have the flexibility to swap things around in tax-advantaged and taxable space, then it probably makes sense to sell TIPS and buy I Bonds up to the annual purchase limit.

You could even sell TIPS in a tax-advantaged account, transfer that to a PenFed CD earning 3%, and buy the same amount of I Bonds using funds from a taxable account (while gaining some tax-deferred space).

I couldn't find a recent TIPS update from Larry Swedroe, but in previous updates he uses the headline CPI estimates from the Philadelphia Federal Reserve to compare TIPS vs. nominal treasuries. Here is a link to the "Fourth Quarter 2013 Survey of Professional Forecasters": Fourth Quarter2013 Survey of Professional Forecasters - Philadelphia Fed According to it:
Over the next 10 years, 2013 to 2022, the forecasters expect headline CPI inflation to average 2.3 percent at an annual rate, up from 2.2 percent in the previous survey. The corresponding estimate for 10-year annual-average headline PCE inflation is 2.0 percent, unchanged from the survey of three months ago.
Looking at the chart in the linked article, the 5-year headline CPI inflation estimate is 2.1%. So if you want to use the headline CPI number as an estimate, the expected real return on a 3% 5-year CD is 0.9%, or 70 basis points more than the I Bond at 0.2%. I believe using the type of analysis Larry uses, this indicates that the CD is a better deal than the I Bond. Another way to look at it is that you are paying 70 basis points of expected return for the inflation protection of an I Bond.

Another consideration is that the CD has much less interest-rate risk than a 5-year treasury. So if inflation and interest rates rise, you can pay a relatively small price (maximum 3%) to exercise your put option on the CD, and reinvest at the higher rate. Thus the CD provides better protection against unexpected inflation than a 5-year nominal treasury, as well as a yield that is more than twice as much.

Kevin
If I make a calculation error, #Cruncher probably will let me know.
Bacchus01
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Re: I Bonds

Post by Bacchus01 »

dad2000 wrote:
Bacchus01 wrote:Still not clear.

Why buy them at all?

10 years or less from retirement. 39.6% marginal tax rate. My tax-deferred is already filled with commodities/REITs/bonds, with all other equities in taxable.

So I rebalance by adding bonds to taxable. My choices are I-Bonds vs munis, and I think I-Bonds are a better choice for my situation.
Sounds similar to my situation. Still not sure why to tie up the money versus hold in a MM or drop into a longer-term CD.
Faith20879
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Re: I Bonds

Post by Faith20879 »

I think it is a reasonable suggestion.

Here is how I see it.

I have a million dollars in my hand, I know I need to diversify - equities, bonds, CDs, MM, Savings Bonds, and etc. All the other options require a bit of research to decide what percentages and who/where to buy from, while with Savings Bonds, there is only one place to buy from and a fixed amount you can buy. This becomes a simple action that I can take right away. I am not saying this is a good or bad thing but I can surely see why a fellow poster who happens to endorse the advantages of SBs would suggest it.

Regards,
Faith
dad2000
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Re: I Bonds

Post by dad2000 »

Bacchus01 wrote:
dad2000 wrote:
Bacchus01 wrote:Still not clear.

Why buy them at all?

10 years or less from retirement. 39.6% marginal tax rate. My tax-deferred is already filled with commodities/REITs/bonds, with all other equities in taxable.

So I rebalance by adding bonds to taxable. My choices are I-Bonds vs munis, and I think I-Bonds are a better choice for my situation.
Sounds similar to my situation. Still not sure why to tie up the money versus hold in a MM or drop into a longer-term CD.

I've been building a ladder ($40k/yr) and am 3 years in, so I don't really see it as tied up since I can cash out pretty quickly. Also, I am probably retiring before my kids are through college, so there is a chance that I get tax-free treatment on half of them. I don't want to over-contribute to the 529s.
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